A Worrying Development for Stock Market Bulls

A New Global Recession

Yes, it seems to be coming. Our friend and longtime Bonner & Partners Family Office member Hense Ellis summarizes:

A new global recession has begun. The collapse in commodity prices and the slump in the emerging market economies will inevitably lead to a sharp drop in global investment and a new surge in unemployment. Moreover, the recent stock market selloff is making matters much worse by creating a negative wealth effect that will cause consumption to fall.

Duncan has a theory about why these things are happening – a lack of “excess liquidity.”

As he puts it, “It’s liquidity that moves the markets. When liquidity is plentiful, asset prices tend to rise, and when it is scarce, asset prices tend to fall.” What investors need, therefore, is some way of measuring and forecasting liquidity. Duncan’s answer is something he calls a “liquidity gauge.”

When the Fed creates dollars through QE, it injects liquidity into the financial markets. Also, when foreign central banks invest their dollar foreign exchange reserves back into the U.S., it adds to liquidity.

On the other side of the equation, when the government borrows dollars to fund its budget deficit, it absorbs liquidity. Duncan:

When total liquidity (i.e., QE combined with the amount of dollars accumulated as foreign exchange reserves) is larger than the budget deficit, there is excess liquidity and asset prices tend to rise. But when total liquidity is less than the budget deficit, there is a liquidity drain and asset prices tend to fall.

Right now, according to Duncan’s model, liquidity will turn negative in 2015 and stay negative for every year until 2019. This is why Duncan is warning his subscribers that this is a “very dangerous moment” for asset prices.

Broken Pumps

Yesterday, we showed how excess liquidity bubbled up in the mortgage finance market. As money was easier to come by – thanks to low rates and rampant securitization of mortgage debt – people bought more houses at higher and higher prices. This pushed up the value of the collateral – houses – which enabled people to borrow even more… and it drove the industry to build more houses and sell them to increasingly marginal (subprime) buyers. Debt and equity raced each other higher and higher until both collapsed in 2007-08. Home prices plunged. And the value of mortgage debt plunged along with them.

Today, thanks largely to the Fed’s bubble, homeownership levels are back to where they were nearly half a century ago.

Now, we see the same phenomenon happening in other sectors. As we reported yesterday, student debt, auto debt, and corporate debt are all headed for trouble. And the bigger picture is that the pumps just aren’t working the way they used to. The growth of the last 20 or 30 years came largely – maybe entirely – from expanding credit.

Banks lent. Consumers, businesses, and government borrowed.

Many of the factory orders went to developing markets, where costs were lower. This left these economies and their central banks with lots of dollar foreign exchange reserves, which they reinvested in U.S. assets.

Mike Dolan at Reuters:

According to the International Monetary Fund, the dollar value of foreign currency reserves held by all developing nations ballooned by almost $7 trillion in just one decade to a peak of some $8.05 trillion by the middle of last year. While China was the main driver, accounting for about half of that increase, its economic boom created a commodity supercycle that flooded the coffers of resource-rich nations from across Asia to Russia, Brazil and the Gulf. As the vast bulk of this hard cash was banked in U.S. Treasury and other low risk, rich-country bonds, they were at least one critical factor in the halving of U.S. Treasury and other Group of Seven government borrowing costs over the same period.

An Ominous Peak

You see? Dollars borrowed out of thin air in the U.S. ended up as foreign currency reserves in the hands of foreign central banks – mainly China’s. What could they do with them? Buy more U.S. government debt. Drive down U.S. borrowing costs. And make it even cheaper for Americans to borrow dollars and send them overseas!

Here’s a graphic our research team created to help you get a clearer picture of what’s been going on…

So you could track much of the global growth binge by looking at China’s foreign exchange reserves. As they went up, more and more money flowed back into U.S. financial assets… and Americans borrowed and spent more and more.

But whoa, whoa, whoa! Those foreign exchange reserves have now peaked. Dolan:

Emerging market forex reserves fell by about half a trillion dollars between mid-2014 and the end of the first quarter of 2015, IMF data shows, and this is likely far from the end.Deutsche Bank estimated on Tuesday the high water-mark of almost two decades of reserve accumulation had now been reached and central banks will by the end of next year dump as much as $1.5 trillion to counter capital outflows.

Of course, as we told you yesterday, we don’t know anything. And even as to that we have our doubts. But it appears that the end of this cycle is in sight. Watch out. By Bill Bonner, Bonner & Partners

3 comments for “A Worrying Development for Stock Market Bulls”

States that dump treasury’s are simply shooting themselves and the global Economy in the head.

The ECB and BOJ seem to understand this.

China has sold to manipulate its currency. As long as there is not an international sell off, doom can be avoided.

If there is a dump I still see the US landing at the top of the pile as currently it is still the strongest currency/safe haven, that everybody wants.

If its gets really nasty it is still, dollar, frank, silver, in about that order. If an implosion is coming Eur, is not something to have.

Dan Romig

Sep 12, 2015 at 7:40 am

Despite what Nobel Prize winning economist Paul Krugman assured us in his Friday, 21 August NY Times column that, “Debt Is Good”, it is not!

Mr. Duncan is correct in his analisys that, ” … when total liquidity is less than the budget deficit, there is a liquidity drain and assets tend to fall.” This should be a wake-up call to Congress and the President, but Capital Hill and Wall Street are tied together, and neither side will alter the new paradigm of national debt exceeding GDP for DECADES to come.

Shills like Krugman reinforce the idea that a huge national debt is not only acceptable, but it is to be expected. Politicians from both the Democratic and Republican two party status quo enjoy the power they wield and the perks sent their way from corporate lobbyists, and as long as they pay lip service to their base and get reelected, it appears that they don’t give a crap about their constituents.

Wall Street’s big players like Jamie Dimon and Lloyd Blankfein can break the laws again and again ( http://www.wallstreetonparade.com ), and get free cash to ‘hold on reserve’ from the Fed’s QE and ZIRP which they then lend out and leverage up to get rich.

Another federal fiscal year comes and goes. Mainstream Corporate media has a trumpet blasting celebration if the annual federal deficit is SMALLER than the year prior, but never the less, still a deficit. With each new year, the debt grows, and as long as T-Notes can be sold at near zero interest, the cycle continues. But remember, on 2 January 2007, a 1 year T-Note carried 5% interest. Batten down the hatches citizens, a nasty storm’s a coming.